Episode 028 - UNICORN-MANIA; Tech Unicorn Valuations are FAKE

Distilling Venture Capital

Tech Unicorn Valuations are Fake

Introduction

• Welcome to Distilling Venture Capital. I am your host, Bill Griesinger
• Distilling VC is a visionary podcast that provides an insightful and informed view of the key trends affecting the VC and tech startup world. My mission is to cut through and go beyond the hype that tends to dominate the tech landscape. And provide you with information you can use.
• It is your podcast for Fintech, DeFi, Blockchain and smart contracts, digital banking and all the frontier Web 3 technologies changing the financial landscape globally.

Hello everyone – it´s been a couple of months since my last podcast episode – I took some time off...It´s great to be back with you again.

After some thought, consideration and a couple defining events, and an announcement by Pitchbook, one of the so called data analytics firms in the VC space, I decided it was imperative that I do an episode in my Unicorn Mania series. I´ll fill you in on the PB announcement I am referring to in a moment – it´s insane!

Before we jump into the episode though, I wanted to pay recognition and acknowledgement to a wonderful Brazilian singer and artist, Gal Costa. My intro music and exit music is Aquarela do Brasil by Gal Costa. Gal Costa passed away on Nov. 9, 2021. A makpr talent in Brazil, I thoroughly enjoyed her music. She will be missed.

So, let´s jump into this edition of Unicorn Mania:

If you´ve followed this podcast in the past, you are aware that in the UnicornMania series I highlight the largely fake, deceptive valuations of VC-backed private technology companies – Which are Fondly called Unicorns...Isn´t that cute?

For background, I refer you to my first episode in the UnicornMania series, March of 2020. Episodes 5 and 6 also deal with this twisted freak show perpetrated by VCs, the tech & financial press and others that engage in all of this Unicorn nonsense. I encourage you to go back to Episode 1 for insights and valuable background information as to why I categorically state and prove that tech Unicorns, a VC-backed tech company allegedly with a $1B or more valuation, are indeed mostly fake…

Let´s start off with some levity and have a little fun, shall we, at the expense of Sil. Valley VCs? I read this a couple years ago in a CrunchBase piece;

There´s an old joke about a new bar in Sil. Valley. On opening day, 6,000 people showed up. No one buys a drink. The business is declared a roaring success! [This joke will hopefully make perfect sense by the time we finish this episode. Only in SV culture would the above be considered a success! In Sil. Valley, comedy often becomes reality

To briefly review, let´s start with some basics I will get into in this episode:

• So, as I just mentioned, the definition of this tech unicorn we hear so much about is: A private VC-backed tech company with an alleged valuation of $1B or more; I say allegedly b/c these valuations are largely fake; I´ll demonstrate that with conclusive evidence in just a moment;
• VCs and others arrive at this distorted value using a completely improper, simplistic method known as the Post Money Valuation – In a moment, I´ll walk through how the Post-Money Valuation is calculated and explain why it is a completely erroneous notion of value;
• On what basis do I call it fakery and deception? Largely b/c it has been conclusively proven beyond a doubt based on the research; The body of evidence comes from a Stanford Univ. GSB study called, ``Squaring VC Valuations with Reality.`` The results were originally revealed at a Silicon Valley Open Doors conf. in 2016 and then officially published in April 2017. It´s been updated since, as late as Dec. 2019. It also has been published in peer-reviewed journals like The Journal of Financial Economics in 2020.
• There are links to both the 2016 video and to the research report in the description of this video
• Links:

Squaring Venture Capital Valuations with Reality

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2955455

Video presentation to the Silicon Valley Open Doors conf., 2016

https://youtu.be/k4OtGWZ3iYI

Why a return to this topic? Several reasons;

1. Because it continues to be an absolute freak show that is out of control. It is a twisted and a deceitful exercise that, as I mentioned, VCs, the tech and financial press and others engage in to ascribe and hype a false value to priv. tech companies; Further, It is an insult to those of us who have an interest in discovering the true value of these tech companies; And Finally, b/c many of the largest mutual fund companies have been investing in the high-risk asset category since at least 2015 (think of Fidelity, T. Rowe Price, Vanguard, JH) – so I view it as a consumer protection issue, well. Where is the SEC?? Where is FINRA? They claim to be interested in protecting the consumer.
2. My mission, as I´ve always stated, is to cut through the BS that tends to dominate the VC & tech landscape to inform you and make you fully aware of what´s going on in this freak show;
3. I stated at the open, one of the defining events that motivated/prompted me to do a Unicorn Mania episode was a recent announcement by Pitchbook, which is owned by Morningstar, btw (acq. in 2016)

That is Morningstar, the venerable, well-known mutual fund rating company founded in 1984. Its star rating system has been considered the gold std in rating mutual funds, ETFs, etc., for years…

4. What is The announcement: I get a daily feed in my email inbox called the Daily Pitch. In the last 30-45 days or so, PB announced they are creating a new index fund for, are you ready for it?; An index of unicorn tech companies. When I saw this I thought, I couldn’t think of anything more ridiculous and useless.

B/C an index that begins with garbage valuations, yields garbage! I will get into that and demonstrate how this alleged index fund is deceiving to investors and should be scrapped immediately…IMO

1. So, when I received this announcement, I immediately downloaded the Whitepaper at the PB website; It is called, ´Harnessing Unicorns; ``Demiystifying the venture capital Market with the Moringstar-Pitchbook Global Unincorn Indexes.``
2. I´ll share some of the key findings and takeaways in a moment – truly a fraud, in my view, to be avoided at all costs – I´ll explain

5. Finally, there was one other event that was a motivating factor. That is, in the wake the FTX implosion, the crypto exchange company that blew up in November 2022, caused by a liquidity crisis of the company's token and fraudulent use of investors funds. As investors all tried to get their money out at the same time, the whole thing collapsed.

Why do I bring up this event? B/C prior to its collapse, FTX would have surely been, no doubt, a part of this bogus index fund. [Just like Wework before, only a couple years ago. Remember them?] WeWork was valued at $47B before pulling its IPO around Sept. 2019 when many entities called BS on its S-1 filing. I devote all of Episode 6 (Aug. 5, 2020) to exposing the Wework fraud and breaking down their bus. model – something, unfortunately, Firms like Pitchbook, CB Insights and the tech press failed to do;

In fact, they continuously published fawning articles prior to Wework´s collapse and implosion, slobbering all over themselves about WeWork´s amazing valuation ($47B)! And now, they want you to trust them with an index of Unicorns based on fake valuations – right! That´s messed up, IMHO.

So, let´s get into this PB announcement, shall we?

Whitepaper Takeaways: It´s a complete mishmash of deceptive jargon, in my view;

• Under, ``Clearly defined eligibility rules:`` The Whitepaper clearly states at the outset it uses the post-money valuation
• Under, ``Quarterly Rebalancing;`` It states, All companies attaining unicorn status in the preceding qtr are eligible for inclusion. [That would have meant FTX, Wework, and other failed, overvalued companies!] Get the picture?
• Under, ``Weighting Methodology:`` It states, ``companies are, weighted using their latest post-money valuation or estimated worth after latest round of outside financing.`` There´s that term again…
• And, ``The model prioritizes a company´s most recent VC deal.`` i.e., post-money valuation;
• Further, it emphasizes, and I quote, ``Past Deals (post-money valuation) is arguably the most important data point used to value unicorns because it reflects real world deals and valuations.`` Are you kidding me?! How about NO, it does not. Completely erroneous statement!
• And, here is one of the real head-scratchers in the Paper under `´Index Calculation`´ - It states, the index is ``calculated once a day at the close of public markets in the US.`` Huh? These are private companies with no reporting of financial results or any other fin. info., for that matter, to the public. There is no correlation b/c of all the private equity rounds of preferred stock are not public either; Each round has its own exclusive rights, protections, economics and terms that usually suck value from prior rounds, especially from common shares.

There is no daily determination of value like in most all mutual funds and ETFs! And Morningstar knows this!

The terms and conditions of these priv. preferred stock financings are not reported to the public and there is no correlation whatsoever to US public markets – there is no repricing daily based on this information.

• This is nothing more than a fake, window-dressing comment to give the false impression that there is some rigorous analysis going on and is correlated to public markets –

Prime Unicorn Index

BTW, in preparing this episode, I discovered there is already an existing Unicorn Index Fund, created in 2017, called Prime Unicorn Index.

On their website they describe it as, ``A modified market cap price return index that measures the share price performance of private companies valued at $1B or more….

I take issue with the term, ``market cap return`` It is not the market cap. Prime reveals that they also use the flawed post-money valuation as one of the factors in calculating value – but the don´t say so on their website!

[Dig into the key highlights and takeaways of the Stanford/Strebulaev Report]

Conclusions

I´ve seen what I would characterize as three major frauds during my professional lifetime where the major institutional entities that we normally rely on to provide us with independent, unbiased assessments and analysis, were all compromised:

1. Dotcom Bubble (2000 – 2001): The Major investments banks were peddling bogus research and analysis on tech company IPOs that had little to no revenue – this helped fuel outrageous valuations;
2. 2008 Financial Crisis: This was a real estate crisis and bubble. The rating agencies were compromised (S&P, Moodys, etc.) and part of the problem and fraud. They erroneously rated packages of low-grade and subprime mortgages as investment grade quality – and you know the rest of the story…

I view Unicorn Mania as, perhaps, just another iteration or vector of the dotcom bubble only with a different twist or flavor. In the dotcom fraud, it was the I-Banks peddling nonsense and hype, unsupported by company fundamentals.

In the Tech Unicorn fraud, the complicit entities are the VCs, tech press, financial press and perhaps accounting firms. They Used a black-box approach, protected by non-public reporting of financial transactions (i.e. Pref. Stock rounds with unique, exotic, and complicated structures). They then peddled a completely useless and inappropriate notion of value via the post-money valuation. This is fraud IMO.

Again, the research supports this conclusion… And this one is inexcusable b/c the hard data and research exists. It is being ignored.